power law distributions 80/20 rule

Having always liked the 80/20 rule as a good rule of thumb for many experiences in business and in life, I was delighted to find it connected to the dysfunctional financial markets as I see them (I know… What do I know? but this stuff just seems so wrong.)

from Wagging the Fat Tail
By Niels C. Jensen
The Absolute Return Letter
October 2007

theory doesn’t work in practice and it may be time that we ditch modern portfolio theory altogether.

Professor Cuno Pümpin … pointed out that returns in financial markets are much more akin to power law distributions than to normal distributions. Unlike normal distributions which occur mostly in static environments, power law distributions occur when three conditions are prevalent: Variety, inequality and dependency. Graphically, power law distributions look very different from normal distributions

Power law distributions are far more frequent than most people realise. Natural disasters, epidemics, war casualties, book sales, internet traffic, income distribution3 as well as returns in financial markets are all examples of power law distributions (and there are many more). Some people also refer to power law distributions as the 80/20 rule.